Market Wrap, Monday, 08/25/2008

Market Wrap

by Robert Ogilvie

The stock markets began the week in a sour tone with the S&P 500 dropping 25
points to 1,266 and the NASDAQ Composite dropping 49 points to 2,365. Volume was
very light on the New York Stock Exchange today with only 865 million shares
traded. That is far less than the 50 day moving average of 1,328 million shares
traded each day. The internals were weak on this late Summer Monday. There were
12 new 52-Week Highs and 101 new 52-Week Lows. Decliners outpaced advancers over
3 to 1 with
2418 versus 700, respectively.

As mentioned in last Mondays commentary, when the $TRIN closes above 2.0 the
probability for a morning bounce increases significantly. The best way to trade
the TRIN is to be prepared about 5 15 minutes prior to the close and place
either a short put spread (bullish) on the S&P 500 (SPX) or S&P 100 (OEX)
options or buy long the S&P eMini futures. With the options there is no way to
have over night risk management on the options themselves but a trader with a
futures trading
account could have a stop order set to sell short the
appropriate number of contracts that represent the cumulative Delta of the short
put spread. For instance, you placed a short put spread on the OEX September
570/560 Put Spread for a net credit of $2.25 per contract and an 11 contracts.
The position has a delta of 100.22 which suggests that the position will lose
$100.22 per point decline in the OEX. Therefore, we can sell short 2 contracts
of the S&P 500 eMini futures (the
futures have a delta of 50 or a change in
value of $50 per point in the S&P futures) to hedge the position if the futures
drop below our overnight risk management level. So either way the TRIN long
position can be hedged and have risk management. Our upside target is either
closing the position at the open or at an 8 point profit target with a 4 point
stop. By the way, last weeks TRIN trade did get stopped out.

Onto the NASDAQ internals, todays advance/decline had almost 4 losers to 1
gainer. The actual numbers are as follows: Advancing Issues = 632, Declining
Issues = 2,228. There were 39 new highs versus 104 new lows on a very low volume
day. Todays volume clocked in at 1,455 million shares versus the 50 day moving
average of 2.08 million shares.

While I am on the internals I am going to cover the Open Interest readings as of
today. The SPX closed at 1266.87 or about 17 points above the peak open interest
(291,406 contracts open) strike price of 1250 on the September puts. The peak
open interest on the calls is at the 1300 strike price with 218,628 open. The
peak levels on the calls represent resistance while the peak levels on the puts
show support.

As in most downtrends there are significantly more puts open than calls. This is
because portfolio managers often purchase S&P 500 puts to hedge their
portfolios. They do this according to their overall correlation to the S&P 500.
For instance, if your diversified stock portfolio is $1,000,000 with a Beta of
1.30 then you would need to buy enough puts to hedge a $1,300,000 ($1 million X
1.30 Beta) portfolio. Hopefully those of you reading this realize that most
option contracts
represents 100 shares of stock or 100 times the value of the
index. Therefore, the notional value of the S&P 500 at 1266.84 equals $126,684
per contract. A quick lesson in Deltas is necessary to figure the next part out.
Delta is a theoretical value assigned to an option that represents the options
potential change in price relative to a one point change in the underlying
securitys price. For instance, assume we join the crowd and buy the 1250
September Put options for $19 per
contract. Each contract has a Delta of
negative 0.38 or profits $38 per contract for each point the SPX declines. By
dividing the Beta adjusted portfolio value ($1,300,000) by the S&P 500 notional
value ($126,684) we get a portfolio multiple of 10.26 or the Beta adjusted
portfolios value per S&P 500 contract. To determine the number of contracts to
buy to fully hedge the portfolio, we take the portfolios multiple and divide it
by the Delta (0.38) to get 27 contracts. Therefore,
we would buy 27 contracts of
the 1250 puts to fully hedge the portfolio. In more stable markets we might see
the S&P Open Interest Put/Call ratio to be skewed toward 1.0 suggesting that
there are fewer put buyers protecting their portfolios and more call buyers
adding positive deltas to increase their portfolios Alpha.

The NASDAQs open interest shows that there is support at 1850 as provided by
the peak open interest of 12,211 contracts open. In addition, the absolute peak
open interest is at the 1700 strike level with 17,725 options open. There is
resistance at 1950 and again at 2100. But the 1950 strike price has the highest
peak open interest with 17.960 opens contracts.

Today in Review

I believe that the market started off in a sour note this morning partly due to
American International Group (AIG) having their third quarter earnings estimate
cut to a loss of $0.86 per share by Credit Suisse. Fitch Ratings placed the
insurance companys credit ratings on a negative watch. AIG dropped to its
lowest level in thirteen years today and closed down $1.09 to $18.78.

The Financial Sector dropped about 3% today on the AIG news as well as news that
South Korean regulators told the Korean Development Bank to be cautious about
taking over any overseas banks. The Korean Development Bank expressed interest
in Lehman Bros (LEH) last week. Shares of LEH dropped $0.96 to $13.45.

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The only three companies that posted a gain in the financial sector were Freddie
Mac (FRE), Fannie Mae (FNM) and MBIA (MBI). The $2 billion debt offering by
Freddie Mac was well received by investors. Fannie and MBIA apparently rose in
sympathy as there was no news surrounding the stock.
The only economic news released today was from the National Association of
Realtors existing home sales report for July. The report was mixed, but signals
that a bottoming process in housing industry is taking shape. The number of home
sales rose by a larger-than-expected amount, while home prices declined. In
addition, the amount of unsold inventory rose to the highest level since at
least 1999. July existing home sales rose 3.1% month-over-month to a seasonally
adjusted 5.00 million
annual rate; which is above the median economist estimate
that called for 1.1% growth to 4.91 million.
Existing home sales are down 13.2% year-over-year. Existing home inventory
supply is 11.2 months, compared to the 2007 average inventory supply of 8.9
months. The inventory of single family homes improved to a 10.6 months supply
from 11.0. The decreased inventory time indicates that falling prices are
helping to stimulate demand. Finally, the median sales price fell 1.3% from the
previous month to $212,400 which is down 7.1% compared to last year. Not that it
feels good but a 7.1%
decline relative to the S&P 500s 14% decline isnt that
bad.

Tomorrows Reasons for Moving

Tomorrow morning the August consumer confidence reports will be released at
10:00 AM. It is expected to be 53 versus last months 51.9. Also at 10:00 AM the
New Home Sales report will be released which should provide some additional
insight into whether housing remains weak overall. The August 5th FOMC minutes
will be released. Usually, the equity markets are fairly quite ahead of the
release. However, currency, credit and equity markets become volatile following
the report.

Most of the stocks reporting earnings tomorrow are international stocks that I
dont trade. Frankly, I dont many of the stocks reporting tomorrow. I used to
trade Chicos FAS (CHS), Corinthian Colleges (COCO) and LTX Corporation (LTXX)
many moons ago. There are a few consumer discretionary stocks reporting tomorrow
including AEO, BIG, BGO, CHS and JCG. Consumer Staple stocks include SFD and
SAFM.

The S&P 500 (SPX)

Today the SPX closed down more than 25 points at 1266.84 on light volume. The
lighter trade suggests that the day was not a distribution day. Another reason
for the light volume was that many traders are taking their vacation the week
before Labor Day.

In this weeks newsletter, I am using a different background color and layout
for the charts. The chart shows three moving averages, the 50, 89 and 200 day
Simple Moving Averages (SMA). The longer term moving averages aid in determining
the overall trend of the underlying security. The SPX is obviously in a long
term downtrend as indicated by all three moving average intervals. As the chart
above shows the market appears to have peaked short term at 1313.15 on August
11th. I have drawn
a Fibonacci retracement from the July low to the peak. The
SPX has been maintaining just above the 50% retracement level as it tries to
break above the 50 day SMA, currently at 1278.82 (green line). If the SPX breaks
below Last Wednesdays low of 1261 then the 50% retracement is the target line.
But we need to see a breach of that level (currently at 1256) and a hold of the
61.8% Fibonacci level before taking a long position. A breach of the 50% level
could be traded with a partial
position with the 61.8% level, less a couple
ticks, the stop loss. There are a number of ways to trade the SPX which include
SPX options, futures, the S&P SPDR (SPY) and the Ultra Long Proshares (SSO). The
next price level support after 1261 is at 1247 which is the August 4th low.
Money Flow remains steady in the 50s but took a dip lower on todays decline in
the market. The Money Flow Index shows that if the market begins to decline that
there is still a lot of room for the indicator
to fall before suggesting a
selling stampede.

As of the close the 8 day Exponential Moving Average (EMA) closed just above the
21 day EMA. A breach of the 21 day EMA by the 8 day EMA would therefore suggests
a negative bias. As a trader, when this bias shifts to negative short trades
should be placed on the initial breach as well as when the price tests the 8 day
EMA. For instance, a short trade on the SPX would be entered at the closing
confirmation of the moving average cross over. Then a buy stop would need to be
placed at
a break of the recent high or some other parameter that meets your
risk appetite. The Bollinger bands are squeezing together which is a reflection
of the recent bit of lower volatility. The low Bollinger band is providing
support at 1249 while the upper Bollinger band has the resistance at 1307. Slow
Stochastics ticked down but hasnt confirmed a sell signal. That will occur once
the Stochastics line closes below the moving average (green line). RSI is
falling fast bust has support at
34. A break below that will suggest further
weakness in the SPX.

The Russell 2000 (RUT)

I want to look at a different market this week. The RUT has held up stronger
than the Dow Jones Industrial, S&P 500 (SPX) and the NASDAQ (NDX). As the charts
below show the RUT did dip down quit a bit in March and July but have had
phenomenal relative strength versus the SPX and Dow.

The RUT has posted a higher low and higher high since the July 15th low, barely.
Stochastics appear different on the RUT chart when compared to the SPXs. For
instance, the RUT is still on a long confirmed because the Stochastics line is
above 20 after re-emerging from below 20 and the Stochastics line is also above
the moving average. However, RSI isnt confirming the long as of todays close.
The Lower Bollinger band is indicating the uptrend and is providing support at
700. There is
also support neat 700 from the early August lows. We need to watch
the 8 day EMA as it is approaching the 21 day EMA. A cross would suggest
weakness in the small caps.

The RUT came down just below the 200 day SMA (719.99) intra day but closed just
above it at 720.54. In addition, the 38.2% Fibonacci retracement at $719.88
provided support today. A break of the 200 day SMA and the 38.2% level would
suggest the 50% retracement level and coincidentally the 50 day SMA as the next
support level. Even though the RUT is showing decent relative strength it
remains in a slight downtrend overall.

The Healthcare sector has been the darling of the Select SPDRs so far this year.
However, the XLV closed below the 21 day EMA which suggests rotation into
another sector may be occurring.

The Consumer Staples SPDR (XLP) is the only sector represented in the Select
Spiders that is still above its 50 and 200 day SMA. One could buy the XLP on
dips and sell short the weaker Sectors like financials (XLF) and materials (XLB)
on spikes. Trade the trends direction. If the trend is down as indicated by the
50 or 200 day SMA sell the sector short on overbought signals. Cover the
position at a risk level that you are comfortable with. For instance, if the ETF
closes above the
21 day EMA or the 8 day EMA closes above the 21 day EMA.
Another method may resemble a Turtle by placing a stop at the break above the 20
day high. Another stop may be relative to volatility of the security. For
instance, on a short trade, one could set a stop at a break of 150% of the 20
day ATR on an up bar. Theses are just some examples. Good trading!